After dropping 1,700 points over the past five trading days, the Dow Jones Industrial Average finally gave investors a breather Tuesday morning, rallying more than 400 points in early trading.
But as good as it feels to see stocks headed higher again, it’s unclear if this is the end of the worst or merely a “dead cat” bounce, Wall Street’s inartful term for a false rally.
There are plenty of reasons why stocks might rebound in the midst of a sell-off.
Some investors may feel like the market overreacted. Others may see real value for equities at these prices. And still others may be reacting to new developments.
This morning, for instance, Wall Street seemed to cheer the fact that Chinese policy makers slashed interest rates and eased banking regulations to stimulate the economy and restore confidence in Chinese equities, which have lost nearly half their value in two months.
Short-term speculators who were betting against equities probably contributed to Tuesday morning’s rise, because they had to rush back in to buy stocks to cover their bad positions—adding to the strength of the rally.
Regardless of the reason, what’s important going forward is how regular investors react at the end of today and tomorrow morning.
A rally in the midst of a sell-off offers investors an out. For instance, some investors may be regretting that they didn’t sell stocks at the end of last week, when the downturn really began to accelerate. Then when Monday came around and stocks fell even more, they lost their opportunity to sell, because now they’d have to lock in even bigger losses.
But Tuesday’s rebound means stocks that investors wanted to sell on Monday are trading at better prices, so they can now recoup more of their losses if they choose to bail.
Does that give you motivation to sell to take advantage of this new window that’s opened up? Or do you feel confident enough that stocks will keep rebounding—and that the bull market will get back on track—to hang on for the long haul?
In a nutshell, that will determine if the six-year old bull market still lives on, or if the selling that began in recent days is the start of a real bear market.
And you will instantly know which option investors have chosen by the start of Wednesday’s trading day.